ECON 4245 Economics of the Firm

Transcription

1 ECON 4245 Economics of the Firm Lecturer: Tore Nilssen, office ES 1216, Seminars: Diderik Lund, office ES 1130, 13 lectures; 6 seminars (in two groups) Lecture slides available before each lecture at: Seminar topics tentative plan 1. Introduction. Fixed-investment model. 2. More fixed-investment model. Variable-investment model. 3. Liquidity management. 4. Asymmetric information. Financing multiple projects. 5. More liquidity management. Monitoring. 6. More monitoring. Each seminar group will be split in six subgroups. Group assignments after break of Lecture 2 (Fri 3 Sep). How to hand in and distribute solution proposals o Fri 3 Sep, , Aud 1 ES. Contact student? Tore Nilssen Economics of the Firm Set 1 Slide 1

2 ECON4245 Economics of the Firm Fall 2010 Department of Economics, University of Oslo Lecturer: professor Tore Nilssen, office ES 1216, Seminars: professor Diderik Lund, office ES 1130, Textbook: Tirole, The Theory of Corporate Finance. Princeton University Press, Lectures: Thursdays 10:15-12:00, ES Aud 3. Seminars: Tuesdays 12:15-14:00 GS Und.rom 2; Fridays 08:15-10:00 HH 301. Lecure dates: Lectures start on 2 Sep. There is an extra lecture on Friday 3 Sep 12:15-14:00, ES Aud 3. There is no lecture on Thursday 7 Oct. So lecture dates are: 2 Sep; 3 Sep; 9 Sep; 16 Sep; 23 Sep; 30 Sep; 14 Oct; 21 Oct; 28 Oct; 4 Nov; 11 Nov; 18 Nov; 25 Nov. Seminar dates: 14 and 17 Sep; 28 Sep and 1 Oct; 12 and 15 Oct; 26 and 29 Oct; 9 and 12 Nov; and 23 and 26 Nov. Exam: 13 Dec at 14:30-17:30 Lecture plan Theme 1. Introduction to corporate finance. Tirole, chs 1-2. [Lecture 1: 2 Sep] Theme 2. Outside financing capacity. Tirole, ch 3, incl supplement. [Lecture 2: 3 Sep] Theme 3. Determinants of borrowing capacity. Tirole, ch. 4, incl supplement. [Lectures 3-4: ] Theme 4. Multi-stage financing: liquidity management. Free cash flow. Tirole, ch 5. [Lectures 5-6] (Lecture break after lecture 6.) Theme 5. Asymmetric information. Tirole, ch 6. [Lecture 7] Theme 6. Product markets. Earnings manipulations. Career concerns. Risk taking. Tirole, ch 7. [Lecture 8] Theme 7. Monitoring. Investor activism. Tirole, chs 8-9. [Lectures 9-10] Theme 8. Control rights. Corporate governance. Takeovers. Investor liquidity. Tirole, chs [Lectures 11-13] Theme 9. Summary of course. [Lecture 13]. Tore Nilssen Economics of the Firm Set 1 Slide 2

3 Course topic: the firm The firm has relationships with o Investors o Creditors o Suppliers o Employees (managers) Applying economics to understand these relationships o The economics of information o Contract theory o Three essential informational problems Hidden action Hidden information Non-verifiable information At the centre stage: the firm/investor relationship o Corporate governance o Corporate finance How are firms managed? How are firms financed? How do informational problems affect these questions? Tore Nilssen Economics of the Firm Set 1 Slide 3

4 Textbook: Jean Tirole, The Theory of Corporate Finance A unified treatment of the topic Building on a simple model o Hidden action (moral hazard) Required reading: chapters 1 through 12, including supplementary sections (unless noted otherwise). Overview Basics: one-stage financing fixed and variable investment models. Applications. Multistage financing: liquidity management Financing under asymmetric information. Exit and voice in corporate governance. Control rights. (in the book, but not in the course: macroeconomic implications of corporate finance; political economy of corporate finance) Tore Nilssen Economics of the Firm Set 1 Slide 4

5 Corporate governance How suppliers of finance to a firm make sure they get returns on their investments. o Investors o Creditors How corporate insiders can credibly commit to returning funds to outside investors, thus attracting external finance o Insiders: management; current owners A narrow definition o Stakeholders vs shareholders Employees, customers, suppliers, communities The separation of ownership and control Berle and Means, The Modern Corporation and Private Property (1932). o Shareholder dispersion managerial discretion Corporate insiders may not act in the interest of the providers of funds. How to deal with this problem? o Incentives o Monitoring Tore Nilssen Economics of the Firm Set 1 Slide 5

6 The moral-hazard problem Moral hazard is an awkward term but the one commonly used o No implication of immoral behavior o Behavioral risk; hidden action Owner/manager conflict o Manager does not always act in the interest of owners Insufficient effort o Insufficient internal control of subordinates Allocation of effort across tasks o Workforce reallocation, supplier switching Overinvestment o Pet projects, empire building, acquisitions Entrenchment o Managers making themselves indispensable o Manipulating performance measures o Being excessively conservative in good times, excessively risk-taking in bad times o Resisting takeovers o Lobbying against shareholder activism Self-dealing o Perks: private jets, big offices, etc. o Picking successor o Illegal activities: theft, insider trading, etc. Tore Nilssen Economics of the Firm Set 1 Slide 6

7 When corporate governance does not work Lack of transparency o Shareholders do not observe compensation details, such as perks and stock options Level of compensation o Tripling of average CEO compensation in the US , a further doubling until o Average CEO/worker compensation ratio in the US went from 42 in 1982 to 531 in o Proponents argue this is a byproduct of more perfomancebased pay. o Norway: average CEO/worker compensation ratio at 10 in 2005 Smaller companies than the US ones Report by Randøy and Skalpe (2007) Fuzzy links between performance and compensation o Bebchuk and Fried, Pay without Performance (2004). o Compensation in an oil company based on stock price, when management has little control over the oil price. o Golden parachutes when leaving. Accounting manipulations o The Enron scandal. o Manipulating stock price, and therefore compensation. o Hiding bad outcomes and therefore protecting against takeovers. Tore Nilssen Economics of the Firm Set 1 Slide 7

8 Managerial incentives Monetary incentives o Compensation Salary: fixed Bonus: based on accounting data Stock-based incentives: based on stock-market data o Bonuses vs. stock-holdings Bonuses provide incentives for short-term behavior Shares provide incentives for long-term behavior The two are complements, not substitutes o The compensation base Relative performance o Shares vs. stock options Stock options provide stronger incentives but do not perform well after a downturn (excessive risk, lack of credibility). o Too low managerial incentives in practice? In the US in the 1980s, the average CEO kept 3 of shareholder wealth; later estimate: 2.5%. But incentives are costly to owners, because of manager risk aversion. Implicit incentives o Keeping the job Firing or takeover following poor performance Bankruptcy o Career concerns o Explicit vs implicit incentives Substitutes: Strong implicit incentives lower the need for explicit incentives but this is difficult to trace empirically. Tore Nilssen Economics of the Firm Set 1 Slide 8

9 Managerial incentives, cont. Monitoring o Boards of directors o Auditors o Large shareholders o Large creditors o Stock brokers o Rating agencies Active monitoring o Interfering with management in order to increase the value of one s claims in the firm. Linked to exercising control rights o Forward looking o Examples large shareholder sitting on the board resolutions at general assembly takeover raid creditor negotiations during financial distress Speculative monitoring o Not linked to control rights o Partly backward looking, aiming at measuring value, rather than at enhancing it. o Example: stock-market analysts, rating agencies o Provides incentives by making firm s stock value more informative about past performance. Product-market competition o Relative performance is easier o Exogenous shocks are filtered out The board of directors o Independence; attention; incentives; conflicts o Many differences across countries. Tore Nilssen Economics of the Firm Set 1 Slide 9

10 Investor activism Active monitoring requires control Formal control vs real control o Formal control: majority owner o Real control: minority owner convincing other owners of the need to oppose management Ownership structure important for the scope of investor activism o Institutional investors: pension funds, life insurers, mutual funds o Cross-shareholdings Firms owning shares in each other o Ownership concentration: huge variations across countries For example: US vs Italy o Ownership stability: again international variation Limits to active monitoring o Monitoring the monitor: incentive problems inside institutional investors o Externalities from monitoring One shareholder s monitoring benefits all shareholders underprovision of monitoring? o Costs of monitoring Illiquidity Focus by management on short-term news Incentives for manipulating accounts Tore Nilssen Economics of the Firm Set 1 Slide 10

11 The market for corporate control Takeovers o Keep managers on their toes o Make managers act myopically Takeover bids: tender offer Takeover defenses o Corporate charter defenses Making it technically difficult to acquire control Staggered board Supermajority rules Differential voting rights o Diluting the raider s equity Scorched-earth policies: selling out those parts of the firm that the raider wants o Poison pills Current shareholders having special rights to purchase additional shares at a low price in case of a takeover attempt o White knight An alternative acquirer who is friendly to the current management o Greenmail Repurchases of stock from the raider, at a premium Management colluding with the raider, at the expense of other owners. Leveraged buyout (LBO) o Going private, borrowing to finance the share purchase o Management buyout (MBO): an LBO by management Tore Nilssen Economics of the Firm Set 1 Slide 11

12 The role of debt in corporate governance Debt provides management discipline o Management must make sure there is cash flow available in the future for paying back debt o Management has less cash available for perks o If the firm does not pay back debt, creditors can force the firm into bankrupty Debtholders are more conservative then equityholders o Debtholders suffer from bad projects, but get no extra benefit from good projects. But there are limits to debt o Debt means the firm is less liquid, which is costly. Internally generated funds are the cheapest source of capital available for firms. o Bankruptcy is costly. Tore Nilssen Economics of the Firm Set 1 Slide 12

13 International comparison Two broad legal traditions o Common law Independent judges Limited codification US, UK o Civil law Politically appointed judges Codification France, Germany, Scandinavia Differences across legal systems o Shareholders have more protection in common law countries o Correspondingly, common-law countries have a higher ratio of external capital to GDP. o Common-law countries have a more dispersed ownership of firms. Note: Supplementary section to Tirole s ch. 1 is not required reading. Tore Nilssen Economics of the Firm Set 1 Slide 13